The Fiscal Policy and the Stability of the nominal Sector: The Romanian Case (revisited version)

Transcription

1 MPRA Munich Personal RePEc Archive The Fiscal Policy and the Stability of the nominal Sector: The Romanian Case (revisited version) Ioan Talpos and Bogdan Dima and Mihai Mutascu West University from Timisoara, Romania 18. November 2008 Online at MPRA Paper No , posted 18. December :00 UTC

2 Ioan Talpoş West University of Timişoara, Faculty of Economics, Timişoara, Romania Bogdan Dima West University of Timişoara, Faculty of Economics, Timişoara, Romania Mihai Mutaşcu West University of Timişoara, Faculty of Economics, Timişoara, Romania THE FISCAL POLICY AND THE STABILITY OF THE NOMINAL SECTOR: THE ROMANIAN CASE (REVISITED VERSION) Keywords: impact, inflation, fiscal policy, econometric analyze, fiscal deficit, budgetary sold Abstract: the fiscal policies in the contemporaneous economic systems heavy influence both the real and nominal sectors. These effects could be located at the primary distribution of the social resources as will as at level their redistribution one. The aims of this paper are: (1) to review the literature of the main conceptual frameworks which link the fiscal policy and the dynamic of real sector, especially on the inflation side (2) to advance an empirical analyze of these link for the Romanian case and (3) to draw some conclusion about desirable framework of the fiscal policy for the current period in the perspective of Romanian access to European Union. 1. INTRODUCTION Specialized international economic literature identifies two types of theoretical approaches regarding the link between inflation and fiscal policy: on one side an approach promoted by Sargent and Wallace (1981) known as The Theory of inflationary fiscal deficit, on the other side an approach formulated by Leeper (1991), Woodford (1995, 1997, 1998) and Sims (1994) known as The Theory of fiscal determination of the level of prices. The theory of the inflationary fiscal deficit tries to explain, on long term, to what extent do significant and persistent deficits determine the in the increase of price indexes and which are the precise ways to counteract their negative effect. The theory of fiscal determination of the level of prices takes in to the effects induced over the inflation by the adjustments of fiscal policy and evaluates the measure in which these can be quantized using empirical investigations. Moreover, it is considered that the de facto level of price should correspond with the one for which the real value of public debt equalizes the present value of future budget excess, ensuring in this way an inter-temporal budget balance. 2. THEORETICAL FUNDAMENTS Knowing the monetary nature of the inflation, economic literatures study the relations between fiscal and monetary policy, as well as the results on their impact over inflation. We remark, as a matter of fact the interaction between the powers of two characteristic

3 authorities: on one side the Govern as a principle promoter of fiscal policy and on the other side the Central Bank, as a forum of conceiving and applying monetary policy. In such circumstances the Govern can force the Central Bank to accept direct financing of the budget deficit or to maintain the refinancing installment at a low level, so that the cost for public credit remains low. Thus, according to Barro and Gordon (1983), a high level of independence of the Central Bank can induce a high level of price indexes when the bank tries to maintain fiscal sustainability in the economy with cost levels as small as possible. Cotarelli et al. (1998) sums up the fact that there is a big impact of fiscal deficit over the inflation, especially in countries in which money markets aren t highly developed; suggesting limited access of governs on those markets and their propensity to ask for help from the Central Bank. Of course, the fiscal-monetary game is not a unique explanation for the effects induced by the fiscal policy on the inflation dynamic. More generally, it could be argued against the thesis of fiscal policy neutrality if there are fulfilled at least two cumulative conditions: (1) inflation is not a pure monetary process but rather a structural-monetary one as an expression of simultaneous disequilibrium in the real and nominal sectors of the economy; (2) the fiscal policy is able to influence the structural determinants of the inflationary processes. We consider that such argument could be especially taking into account in the case of an emergent economy as the Romanian one which is in a phase of deep structural, functional and institutional transformations. Thus our analytical objective is to provide some evidences for the thesis of fiscal policy non-neutrality in such a case. The next section describes the empirical analysis framework and the results derived from its appliance for the Romanian involved variables in the last 10 years of transition (monthly data provided by National Bank of Romania public disclosure in its publications). A brief discussion of the results is done in Section 4 and some conclusions are formulated and some further research directions are suggested in Section 5. The main output of the proposed analysis consists in finding some supportive empirical evidences for a relevant impact of fiscal policy over the inflation dynamic in a short time span. 3. METHOD AND RESULTS In order to test the links between the inflation and some budgetary macro-variables (public revenues and public expenditures) a Vector Error Correction (VEC) could be involved. The VEC methodology presents several advantages. In particular, it allows building a model of the connections between some co-integrated variables, being extremely useful in the study of the economic fluctuations. A VEC model is a particular restricted Vector Error (VAR) model designed for use with non-stationary series that are known to be co-integrated. The VEC has co-integration relations built into the specification so that it restricts the long-run behavior of the endogenous variables to converge to their co-integrating relationships while allowing for short-run adjustment dynamics. The co-integration term is known as the error correction term since the deviation from long-run equilibrium is corrected gradually through a series of partial shortrun adjustments. To take the simplest possible example, consider a two variable system with one co-integrating equation and no lagged difference terms. The co-integrating equation is: y = β y 2, t 1, t ( 1 ) 2

4 The corresponding VEC model is: y y 1, t 2, t = = α α 1 ( y 2, t 1 β y 1, t 1 ) + ε 1, t ( y β y ) + ε ( 2 ) 2 2, t 1 1, t 1 In this simple model, the only right-hand side variable is the error correction term. In long run equilibrium, this term is zero. However, if y 1 and y 2 deviate from the long run equilibrium, the error correction term will be nonzero and each variable adjusts to partially restore the equilibrium relation. The coefficient α i measures the speed of adjustment of the i -th endogenous variable towards the equilibrium. The vector of the endogenous variables has the following representation: [ IP VP ] Y t = t t CHP t (3) where: IP - variations in the level of inflation, VP - variations in the level of public revenues, CHP - variations in the level of public expenditures and t represent the current period t. Variations that can be expressed as: X t xt ln * 100 X = (4) t 1 For presenting how such a model can be applied in approaching the inter-linkages between inflation, public revenues and their allocation, in an instable economic system, as in Romania, we propose an analysis made for September December 2007 period, which was shaped by important changes in the fiscal policy. The seasonal effects are drawn from the original data by the usage of an X12-ARIMA procedure in order to preserve a more stable interaction between the involved variables. Despite some differences between them, the group unit root tests suggest that there could be identified some common unit root processes which are driving the involved variables but not individual unit roots: Group unit root test: Summary Sample: 1998M M12 Exogenous variables: Individual effects, individual linear trends User specified lags at: 6 Andrews bandwidth selection using Quadratic Spectral kernel Balanced observations for each test Cross- Method Statistic Prob.** sections Obs Null: Unit root (assumes common unit root process) Levin, Lin & Chu t* Breitung t-stat Null: Unit root (assumes individual unit root process) Im, Pesaran and Shin W-stat ADF - Fisher Chi-square PP - Fisher Chi-square , t 3

5 Null: No unit root (assumes common unit root process) Hadri Z-stat ** Probabilities for Fisher tests are computed using an asympotic Chi -square distribution. All other tests assume asymptotic normality. The estimation of the general model parameters described by the relation (3) leads to following results: Vector Error Correction Estimates Sample (adjusted): 1998M M12 Included observations: 112 after adjustments Standard errors in ( ) & t-statistics in [ ] Cointegration Restrictions: B(1,1)=1 B(1,2)=0 B(2,1)=0 B(2,2)=1 A(2,1)=0 A(3,1)=0 A(1,2)=0 Restrictions identify all cointegrating vectors LR test for binding restrictions (rank = 2): Chi-square(3) Probability Cointegrating Eq: CointEq1 CointEq2 IP_SA(-1) VP_SA(-1) CHP_SA(-1) ( ) ( ) [ ] C Error Correction: D(IP_SA) D(VP_SA) D(CHP_SA) CointEq ( ) ( ) ( ) [ ] [ NA] [ NA] CointEq ( ) ( ) ( ) [ NA] [ ] [ ] D(IP_SA(-1)) ( ) ( ) ( ) 4

6 [ ] [ ] [ ] D(IP_SA(-2)) ( ) ( ) ( ) [ ] [ ] [ ] D(IP_SA(-3)) ( ) ( ) ( ) [ ] [ ] [ ] D(IP_SA(-4)) ( ) ( ) ( ) [ ] [ ] [ ] D(IP_SA(-5)) ( ) ( ) ( ) [ ] [ ] [ ] D(IP_SA(-6)) ( ) ( ) ( ) [ ] [ ] [ ] D(VP_SA(-1)) ( ) ( ) ( ) [ ] [ ] [ ] D(VP_SA(-2)) ( ) ( ) ( ) [ ] [ ] [ ] D(VP_SA(-3)) ( ) ( ) ( ) [ ] [ ] [ ] D(VP_SA(-4)) ( ) ( ) ( ) [ ] [ ] [ ] D(VP_SA(-5)) ( ) ( ) ( ) [ ] [ ] [ ] D(VP_SA(-6)) ( ) ( ) ( ) [ ] [ ] [ ] D(CHP_SA(-1)) ( ) ( ) ( ) [ ] [ ] [ ] D(CHP_SA(-2)) ( ) ( ) ( ) [ ] [ ] [ ] 5

7 D(CHP_SA(-3)) ( ) ( ) ( ) [ ] [ ] [ ] D(CHP_SA(-4)) ( ) ( ) ( ) [ ] [ ] [ ] D(CHP_SA(-5)) ( ) ( ) ( ) [ ] [ ] [ ] D(CHP_SA(-6)) ( ) ( ) ( ) [ ] [ ] [ ] C ( ) ( ) ( ) [ ] [ ] [ ( ) ( ) ( ) [ ] [ ] [ ] R-squared Adj. R-squared Sum sq. resids S.E. equation F-statistic Log likelihood Akaike AIC Schwarz SC Mean dependent S.D. dependent Determinant resid covariance (dof adj.) 1.42E+09 Determinant resid covariance 7.37E+08 Log likelihood Akaike information criterion Schwarz criterion In order to check the appropriateness of the estimated VAR and the VEC specification stability the inverse roots of the characteristic AR polynomial could be analyzed. Such an analysis confirms that the estimated VEC could be considered as stable since there is only 1 unit root as is imposed by the VEC specification and therefore in terms of involved parameters the stability of the model could be considered as good enough : Roots of Characteristic Polynomial Endogenous variables: IP_SA VP_SA CHP_SA Exogenous variables: Lag specification: 1 6 6

8 Root Modulus i i i i i i i i i i i i i i i i i i VEC specification imposes 1 unit root(s). Based on these results we could consider that this model satisfactory describes the connection between implicated variables. Its use allow us to make an approximation of the impulse function form, which estimates the inflation evolution caused by a shock in the revenues level or in the public expenditures level: Accumulated Response to Cholesky One S.D. Innovations 20 Accumulated Response of IP_SA to VP_SA Accumulated Response of IP_SA to CHP_SA

9 4. DISCUSSIONS As the impulse functions from chart suggests, an initially exogenous shock in the dynamic of public revenues exercises initially a reduction in the inflation rate, followed in a 2-3 month by an up adjustment. After this period, the translated effects reach a lower peak in two quarters and are slowly absorbed after that. Similarly, an expansion of the public expenditures contributes to the inflationary tensions in a quarter. Such effect is slowly absorbed in 2-3 quarters. It is important to remark that the ensemble of these effects is short-termed, reaching maximal levels in first two post-impact quarters. In other words, changes in the configuration of public decision mentioned determinants are fast and instable rebounded upon the dynamic of revenues and expenditures flows, determining frequent inter-correlated adjustment and exerting a fast reaction on the prices formation mechanisms. This framework could also be applied for the study of variances decomposition: Period S.E. IP_SA VP_SA CHP_SA Cholesky Ordering: IP_SA VP_SA CHP_SA It could be noticed that the public revenues and expenditures contributes almost in the same proportion to the inflation rate volatility and the increases in these variables volatility are fast transmitted on inflationary behavior with induced effects being saturated in two quarters. 5. CONCLUSIONS The analysis presented in this paper had in mind to envisage the way of manifestation of the correlation between public resources, their allocation and the prices evolution. Results obtained suggest the existence of some fast adjustment processes inducted by the intrinsic characteristics of the fiscal policy, by the specific behaviour of the public authorities, particularities that are active in adoption and application of the public decision and also by the imperfect correlation between the fiscal and monetary policies. In other words, the impact of the fiscal policy on the costs levels, the modalities chosen by the public authorities to finance the public deficit as well as the inflationary expectations induced to the economic subjects could counter-balance the effects of a restrictive monetary policy. The main analytical development directions are: 8

10 Widening of conceptual framework taken into consideration explicitly determinant factors of correlation between public revenues and public expenditures; Adoption of some alternative methodologies for empirical testing of these determinants way of manifestation; Taking into consideration the case of other emerging economic systems. REFERENCES 1. Barro, R. J. and D. Gordon (1983), A positive theory of monetary policy in a natural rate model, Journal of Political Economy, Vol. 91, No. 4, pp Cottarelli, C., M. Griffiths and R. Moghadam (1998), The Nonmonetary Determinants of Inflation: A Panel Data Study, IMF Working Paper, WP/98/ Dima, B. (2001), Inflaţia structurală în România, Ed. Augusta, Timişoara. 4. Leeper, Eric (1991), Equilibrium under Active and Passive Monetary Policies, Journal of Monetary Economics 27(1), pp Mutaşcu, M. (2005), Finanţe publice, Ed. Artpres & Augusta, Timişoara. 6. Rother, P.C. (2004), Fiscal Policy and Inflation Volatility, Working Paper Series, No.317, pp Sargent, T. and N. Wallace (1981), Some unpleasant monetarist arithmetic, Federal Reserve Bank of Minneapolis Quarterly Review, Fall, pp Sims, Christopher A. (1994), A Simple Model for Study of the Determination of the Price Level and of the Interaction of Monetary and Fiscal Policy, Economic Theory, 43(3), Talpoş, I (1999), Creditul public, Ed. Sedona, Timişoara. 10. Talpoş, I (1995), Finanţele României, Ed. Sedona, Timişoara. 11. Woodford, M. (1998), Comment on A frictionless view of U.S. inflation by John Cochrane, NBER Macroeconomics Annual, No. 13, pp